THEORY OF SUPPLY

Draw the coloured lines in the diagram as dotted lines

#1 Exceptions to the law of supply.

Backward bending supply curve:

In case of labour it is noticed that initially when wages are increased (up to W), supply
of labour also increases as work is preferred to leisure. Hence, we have an upward
sloping supply curve initially. However, if wages are increased beyond a certain level
(W), it is noticed that there is a fall in the supply of labour as leisure is preferred to
work. Hence, the supply curve bends backward after point b.
y

Leisure is preferred to
work

Wage Rate Pw

(price of labour) Work is

preferred to
leisure

0 QL labour supply x

Vertical supply curve:

In case of certain commodities like old manuscripts, old coins, classical paintings, old
stamps etc, supply cannot be changed. The same phenomenon is also observed for
agricultural products (perishable goods) in the very short period. Hence, the supply
curve is this case is vertical in nature.
y

price S

0 S quantity supplied x
1
 Downward sloping supply curve

Due to better utilization of fixed factors and specialization, every firm passes through a
phase of increasing returns, i.e. it is able to supply more at lower price. Hence, the
supply curve of a decreasing cost industry is downward sloping.
. y

Price S

0 Quantity supplied x

#2 Distinguish between extension/expansion and contraction of supply.[Table 1]

[ It is also referred to as change in quantity supplied ]

Extension/Expansion of supply Contraction of supply

1. More quantity is supplied at a 1. Less quantity is supplied at a lower
higher price, other factors affecting price, other factors affecting
supply remain constant. supply remains constant.

2. Causes an upward movement 2.Causes a downward movement

along the supply curve(a to b) along the supply curve.(b to a )

3. Schedule: 3.Schedule
Price (Rs) Quantity(kg) Price (Rs) Quantity(kg)
5 10 10 20
10 20 5 10

4. Curve: 4. Curve:
y y
Price S Price S
10 b 10 b
5 5
S a S a
0 10 20 x 0 10 20 x
Quantity Supplied Quantity Supplied

2
#3 Distinguish between increase and decrease in supply. [Table 2]

[ It is also referred to as change in supply ]

Increase in supply Decrease in supply

1. More quantity is supplied at the 1. Less quantity is supplied at the
same price. same price.

2. Price remains constant but- 2. Price remains constant but-

* technology improves,
* input prices fall,
* price of substitutes falls,
* taxes lowered and subsidies
increased.
* technology deteriorates,
* input prices rise,
* price of substitutes rise,
* taxes raised and subsidies
decreased.

3. Causes a rightward shift of the 3.Causes a leftward shift of the

supply curve (a to b). supply curve. (b to a)

4.Schedule: 4.Schedule:
Price (Rs) Quantity(kg) Price (Rs) Quantity(kg)
5 10 5 20
5 20 5 10

5. Curve: 5. Curve:
y y
Price S S1 Price S1 S

5 a b 5 a b
S S1 S1 S

0 10 20 x 0 10 20 x
Quantity Supplied Quantity Supplied

#4. How is movement along a supply curve different from a shift of the supply
curve?

Movement along the supply curve Shift of the supply curve

1.It indicates a change in the quantity
supplied due to a change in price of the
commodity, other factors affecting
supply remaining constant.
1.It indicates a change in the supply
due to a change in the other factors
affecting supply except its own price.
3
 2.Causes an upward or a downward 2.Causes a leftward or a rightward
movement along the supply curve. shift of the supply curve.
(Contraction - b to a) and (Decrease - b to a) and
(Extension - b to c) (Increase - b to c)
3. y 3. y
S
Price P3 c Price S2 S1 S3

P2 b P a b c

P1 a S2 S1 S3
S
0 Q1 Q2 Q3 x 0 Q1 Q2 Q3 x
Quantity Supplied Quantity Supplied

Note: Difference between extension and increase or contraction and decrease can be
written placing compatible points side by side, from the above tables 1 and 2, on the basis
of definition /what remains constant /nature of movement or shift / diagram.

#5 Time period and supply

Very short run:

It is a period in which supply cannot be changed.
The maximum supply is the stock of the good already produced.
It is applicable for highly perishable commodities and things of antique value.
It is also called the market period.
The supply curve S1S1 is vertical.

Short run:
It is a period of time in which supply can be adjusted as producers may increase
production up to a certain extent by running the plant for a longer period using the
available resources.
The supply curve S2S2 is upward sloping ( inelastic in nature)

Long run:
It is a period of time when firms build new plants.
New firms may enter the market and bring about a large change in the quantity
supplied.
The supply curve S3S3 is upward sloping (elastic in nature)
4
 y

Price S1 S2 S3

S3

S2

0 S1 Quantity Supplied x

#6. Why is the supply curve upward sloping?

Profit motive of individual firm:

If the average price is more than the minimum price at which a firm is ready
to supply a given quantity of a commodity ‘X’, it may earn excess profit. So,
to maximise its profits a firm may start supplying more of the commodity at
higher prices.

An increasing cost industry:

In the long run, higher prices may attract new firm to enter the industry.
However, input costs may also rise. So, firms will be willing to supply more
at higher prices in order to cover the increased costs of production.

Incentive to other firms:

Rising prices not only act as an incentive for the existing firms to increase
their output but also encourage new firms to enter the industry leading to an
increase in supply.

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